Arthur Laffer, author of supply side economics in the Kemp-Roth tax cuts proposed in the late 70s and finally passed in 1981, has a column today on the origins of the Great Depression. Books have been written on the subject and recent books have revised much history. Today Laffer points out that tax policy had a powerful effect on the collapse. We all know the theories of Keynes, about how falling demand led to the contraction. We have read (many of us have, anyway) Amity Schlaes book and realized that regulation and the effort to keep wages high contributed. Schoolchildren of my generation knew about the Smoot-Hawley tariff and how it led to trade wars and decreased world trade. Laffer now contributes another factor. Taxes.
While Fed policy was undoubtedly important, it was not the primary cause of the Great Depression or the economy’s relapse in 1937. The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy’s relapse in 1937.
I had not previously thought of Smoot-Hawley as a tax but, of course, it was. Until the 16th Amendment, tariffs were the government’s principle source of revenue.
In 1930-31, during the Hoover administration and in the midst of an economic collapse, there was a very slight increase in tax rates on personal income at both the lowest and highest brackets. The corporate tax rate was also slightly increased to 12% from 11%. But beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25%. (That’s not a misprint!) The corporate rate was raised to 13.75% from 12%. All sorts of Federal excise taxes too numerous to list were raised as well. The highest inheritance tax rate was also raised in 1932 to 45% from 20% and the gift tax was reinstituted with the highest rate set at 33.5%.
Raising taxes in a recession is not only an illogical idea, Keynes says government should run a deficit in recessions, but is a proven cause of the Depression. Roosevelt, as in so many other areas, followed Hoover’s lead.
In 1934, during the Roosevelt administration, the highest estate tax rate was raised to 60% from 45% and raised again to 70% in 1935. The highest gift tax rate was raised to 45% in 1934 from 33.5% in 1933 and raised again to 52.5% in 1935. The highest corporate tax rate was raised to 15% in 1936 with a surtax on undistributed profits up to 27%. In 1936 the highest personal income tax rate was raised yet again to 79% from 63%—a stifling 216% increase in four years. Finally, in 1937 a 1% employer and a 1% employee tax was placed on all wages up to $3,000.
It has been written that Roosevelt took great delight in those high tax rates on his fellow members of the inherited wealth class. He was widely hated in return but the hate seems to have gone both ways.
The states also made their contribution to the collapse.
In 1929, state and local taxes were 7.2% of GDP and then rose to 8.5%, 9.7% and 12.3% for the years 1930, ’31 and ’32 respectively.
If there were one warning I’d give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s. Net legislated state-tax increases as a percentage of previous year tax receipts are at 3.1%, their highest level since 1991; the Bush tax cuts are set to expire in 2011; and additional taxes to pay for health-care and the proposed cap-and-trade scheme are on the horizon.
I believe that the only way this warning will be heard is if the Republicans take Congress next year. Hopefully, they have learned their lesson from the early years of this decade.